With expensing, the first tax is abolished. Saving is, in effect, deducted in computing the tax."
The following list summarizes the key aspects of the flat tax (Rabushka, 1997):
1. "The flat tax, in effect, removes the tax code from the economy. No individual, household, or firm needs to take into account any tax complications that arise from their economic decisions and activities. The tax system is designed for the sole purpose of collecting revenue, not for social manipulation of individuals or firms.
2. The flat tax is pro-investment because it permits 100%, first-year writeoff of all investment.
3. The flat tax is non-discriminatory, in that it treats every individual, household, and firm exactly the same. It is fair in this regard. This is an important point of principle, namely, that of enhancing individual economic freedom. The flat tax does not punish success.
4. The flat tax is the essence of tax simplification. It is completely transparent. Everything you need to know to understand the system is contained on the two proposed forms for reporting individual and business tax liabilities.
5. The flat tax promotes economic growth. The consensus of scholarly studies is that a low flat tax would result in higher growth in those countries which now have graduated income tax systems.
6. The flat tax is easy to administer. Revenue from business cash flow is collected at source, except for wages, which is withheld at source and directly transmitted to the government.
7. The flat tax increases individual incentives to work, save, invest, and take entrepreneurial risks. The rate of tax in a flat tax system is lower than the top rate in graduated tax systems.
8. The flat tax eliminates political lobbying on the part of special interest groups."
Case for the Flat Tax System
The majority of citizens in various areas across the world accept that they must contribute to the cost of public goods and services, such as the police and social services (Kerr, 2004). Most agree that taxation is the best way to do so. However, there is a great deal of disagreement when it comes to how people should be taxed.
There are three basic ways taxes can be collected (Kerr, 2004). The first is a head or poll tax, which is a fixed exaction upon individuals of an amount that does not correlate to one's income. Under this system, a janitor and a stockbroker pay the same level of tax.
The second basic type of taxation is a progressive tax (Kerr, 2004). Under this system, the rate of taxation increases as the amount of money subject to the tax increases. For example, New Zealand's income tax is a progressive tax. The rate of tax applied to the first dollar of income is 15% while that applied to each dollar of income over $60,000 is 39%. The rate of tax may start at zero and rise to 100%.
The third option is a flat tax (Kerr, 2004). Under this system, the rate of tax remains the same regardless of the amount of income earned. The janitor and stockbroker would pay the same rate of tax. However, the stockbroker would still pay more total tax than the janitor because he earns more money.
Head taxes are not popular in many areas of the world. According to Kerr (2004): "At first sight they may seem bizarre. Yet we accept a somewhat similar approach every day when we belong to a gym, society or club: membership generally means flat dues for everybody. Similarly, prices charged by supermarkets do not depend on the income of the shopper. The head tax, however, runs into serious problems if the tax is more than trivial. If taxpayers earned little income relative to the level of the head tax, they would face severe hardship. The government might decide to remit the head tax on people who do not earn a minimum level of income, but this would create problems. It would need to raise additional tax from other people to compensate for the revenue forgone. The head tax has gone out the window."
Thus, it is important to ask whether a flat tax or progressive income tax is a more desirable option (Kerr, 2004). A flat tax appears to be a more robust option than a progressive tax. It is fairly easy to set the rate of tax and calculate the amount of tax paid by each taxpayer with a flat tax. It does not matter whether income is earned through a company or fund, or as a fringe benefit. All income is taxed at the flat rate. Because every taxpayer pays the same rate of tax, there is less room for the level of tax payable by various groups to be changed simply for political reasons.
The progressive tax is a more complicated system (Kerr, 2004). The government needs to figure out which particular progressive tax scale it supports out of the vast number that could be created. This choice is a political question. There is no principle to resolve it in an objective fashion.
Many people claim that an increase in the progressiveness of the tax scale is justified on fairness grounds (Kerr, 2004). There is no limit to these arguments. A little more progressivity is always seen as fair.
The flat tax is commonly perceived as a benefit to the rich (Kerr, 2004). People who make more money initially benefit more than those who earn less. However, over long periods of time, higher productivity may be better for everyone. A progressive tax scale discourages productivity and negatively affects living standards more than an equivalent flat tax.
Richard Epstein, a leading legal scholar at the University of Chicago, claims that the shape of a progressive tax scale leads to what he called the Goldilocks problem (Kerr, 2004). This is the constant search for a schedule of tax rates that is 'just right'.
If there is little difference between the bottom and top tax rates, what is the point of greater complexity and costs entailed in implementing a progressive tax? However, if the tax scale is highly progressive, people who generate wealth and jobs are encouraged to participate in wasteful tax avoidance activities and some might move to other countries (Kerr, 2004).
Epstein observes that there is great reluctance in the United States to have progressive tax systems at the state level because, "the folks who live in California can happily relocate to Nevada with a lower tax base (Kerr, 2004)." Tax competition is a major restraint on the level of taxes and the progressivity of tax scales. Thus, it seems that a flat tax is generally better than a progressive one. Paying taxes is not considered a pleasurable activity for most, but it could become somewhat less painful for many citizens if flatter income tax systems are implemented.
Benefits of the Flat Tax System
There are many types of proposals for tax reform and one of the strongest is the flat tax reform proposal, which promises to simplify income tax preparation and reduce the opportunity for cheating (Bradley, 1984). The concept is simple. Individuals and corporations are taxed at the same rate. Savings and investments are exempt from tax, eliminating double taxation and promoting savings and investments necessary for economic growth. The preparation of tax returns is simplified by allowing for just four types of personal deductions. Tax credits and other deductions will no longer be available, which is a benefit as this simplifies the calculation of net income and taxes. Corporations will no longer be able to deduct interest payments on debt. This proposal may also result in an increase of collections from companies. For individuals it stands to significantly reduce the tax rate for many, increasing the tax base, encouraging more people to file, and discouraging cheating.
With a flat tax system, Hall and Rabushka (1995) argue that tax forms could fit on postcards. A simple tax system takes only a few easy calculations, as opposed to the complexity of today's progressive income taxes.
The flat tax would reduce the negative twist in the progressive tax system (Auerbach, 1997). The flat tax has a single, uniform incentive for all investments. Basically, businesses report all purchases of equipment and buildings as expenses. Auerbach observes that using a flat-rate consumption tax in place of an income tax would raise the ratio of capital stock to GDP from 5.0 to 6.2.
Like that of many other countries, the United States' federal income tax system needs a great deal of improvement (Carroll et al., 1998). The process of filing should not be complicated and time-consuming. This is important because it will deter taxpayers from taking shortcuts, cheating and choosing not to report income. Thus, an improved tax system would result in higher tax collections. When it comes to corporations, legislators need to realize that they have enjoyed paying less than half of the statutory 35% federal corporation tax rate for many years. Companies like…